Circle Rental Management, LLC, didn’t own any apartments when it made an offer to buy Meisner Village in Salem, N.H. So principal Nelia Jacobs and the company’s other officers didn’t exactly have a long list of contacts in the multifamily lending business to call.
Small apartment investors face the same problem across the country. Local banks dominate the business of making small apartment loans, but they may not offer the best terms or be fast enough to close the deal. Worse, government regulation may soon force some small banks to cut back on their real estate lending activities.
Fortunately, new lenders are eager to get into the business. Conduit, Fannie Mae, and Freddie Mac program lenders are all finding new ways to make small loans, and some of these loan programs are already making a difference for borrowers like Circle.
Circle didn’t have much time to close the deal. After finding the property listing in October, Circle spent much of November trying to find a lender. Three or four other potential buyers had bid on the property, and Circle’s bid, $4.5 million for the 42 apartments, or about $106,000 a unit, wasn’t high enough to make the seller wait.
With only one vacant apartment out of 42 well-maintained two- and three-bedroom units, Meisner Village seemed like a great deal. Rents range from $995 a month to $1,350 a month at a property with little competition from other apartment communities.
Circle worked with several local banks that seemed eager to lend at first, but a few didn’t even call back once Circle asked for terms. Other banks insisted on having a Small Business Administration guarantee on the loans, an extra layer of paperwork that would have added even more time.
Fortunately, Circle found faster financing through Arbor Commercial Funding, LLC, a branch of Arbor Commercial Mortgage, LLC. Arbor offered Circle a $3.6 million loan through Fannie Mae’s 3MaxExpress small loan program. Circle inked a purchase and sale agreement in December, and the loan closed in mid-February.
Unlike many of the local bank loans that Circle investigated, Arbor’s 10-year mortgage will amortize over 30 years, lowering Circle’s monthly mortgage payments.
Also, Arbor’s loan allowed Circle to take on a $370,000 loan from the seller, even though the seller’s loan wasn’t secured by the property. As a result, Circle only had to put $480,000 of its own equity into the purchase, or a little more than 10 percent.
Even better, escrows and closing costs only totaled about $100,000 for the loan, or about two and a half points. Arbor did not reveal the interest rate for its loan, though mortgages through Fannie Mae’s 3MaxExpress program typically range from 100 to 150 basis points over the yield on Treasury bonds, which averaged 4.56 percent in December.
Circle’s loan can also be re-leveraged back up to 80 percent of the value of the property twice during the loan term, allowing the owner to cash in on increased value.
Local banks step back from small loans
As new lenders are expanding their small loan products, regional and local banks are confronting tighter regulation that may force some of them to scale back their business.
Regulators fear the banks might be overextended. In 2006, the federal Office of the Comptroller of the Currency noted that 30 percent of national banks hold commercial real estate loans in amounts exceeding 300 percent of their capital. Nearly all of these institutions are mid-sized or community banks.
The Comptroller has issued guidance that demands these banks enhance their risk management and increase their level of capital if commercial real estate loans made for construction, land development, or other land total more than 100 percent of the bank’s capital.
That could leave smaller local banks with less money to lend and tighter restrictions on the loans they do make, just as competition from larger lenders is heating up.
“There are an enormous number of folks trying to get into the business,” said Charles Krawitz, managing director for LaSalle Bank, a Midwestern commercial bank that makes loans nationwide. A few commercial banks like LaSalle and Washington Mutual have begun securitizing small permanent loans originally made from the bank’s balance sheet.
Because these loans aren’t securitized as commercial mortgage-backed securities, they look a little different than typical conduit loans. They are typically recourse loans, unlike most conduit mortgages.
The loans might not require a third-party appraisal or an environmental or engineering report, however, and the lender might require only annual reports instead of quarterly financials.
How does all this affect the small apartment borrower? “The net effect is that he doesn’t have to go in to his local bank anymore,” Krawitz said.
Balance sheet lender fights to make small loans
Not all banks that keep small loans on their balance sheets are stepping back from originating these loans.
Large commercial bank Citigroup is expanding its small loan business. While Citigroup’s conduit lending arm focuses on loans larger than $10 million, at Citigroup Commercial Real Estate Finance, the average apartment loan is just $2 million, and the bank can make loans as small as $750,000.
These flexible permanent loans, made from Citigroup’s balance sheet, are typically fixed-rate for the first few years, then float for the rest of the loan’s 15-year term with payments that are amortized over 30 years and carry a balloon payment at year 15.
Prepayment penalties are also relatively light, starting at 5 percent and dropping 1 percentage point a year. The loans can also be assumed if the property is sold. Citigroup originates these loans in most of the markets where it has branch banks, concentrating on the larger metropolitan areas.
As the price of apartment properties rises faster than the income generated by the apartments, the size of Citigroup’s loans is generally constrained by the debt-service coverage ratio. Citigroup demands that a property have income 1.15x to 1.2x the mortgage payments.
Interest rates hover at about 150 basis points over the yield on matching Treasury bonds, if not lower, according to Thomas Lawyer, managing director for Citigroup. That is typical for the small loan business, though interest rates are beginning to creep lower.
“I can’t compete on flexibility all the time,” Lawyer said. “Some people want price.”